At GM, a Look Under the Balance Sheet Hood

Its completely legal use of special purpose entities is still a lesson in U.S. accounting.

In detailing its use of special purpose entities for various financing transactions, General Motors ( GM) has both illuminated a previously gray area of its balance sheet and shed light on accounting that has occasionally made investors nervous in recent months.

To be sure, the techniques employed by General Motors are perfectly legal and permissible under generally accepted accounting principles. They don't smack of the aggressive strategies that got companies like Enron into trouble. Nevertheless, their sheer ubiquity at GM and throughout corporate America gives some observers reason for pause.

In an 8-K filing, GM said it has used off balance sheet SPEs to securitize and sell certain financial assets. The assets securitized or sold by GM's financing arm, General Motors Acceptance, amount to $132.8 billion while the assets sold by GM amount to $868 million, the firm said.

"We've disclosed this before but not with the same level of detail," said spokesman Jerry Dubrowski.

Mixed Blessing

Some experts were pleased with the added level of disclosure, but said it doesn't change the fact that the world's largest automaker is still attempting to make its financial statements appear rosier than they really are.

"They have 'sold' and presumably booked gains on the sale of financial assets receivables and loans while retaining a substantial portion of the risk of no-payment on those assets. These are measures that present a different impression than might seem intuitive," said Jeff Brotman, adjunct professor of accounting at the University of Pennsylvania's Law School.

"Being able to incur a liability without disclosing that liability, and doing so by applying GAAP in a permissible manner, is, to me, what we're today calling creative accounting," Brotman said.

Companies that securitize or sell loans to an SPE typically retain an interest in those loans, meaning it is possible for that debt to be forced back onto the balance sheet if the credit picture starts to erode rapidly, experts say.

"Although ABS asset-backed securitization transactions are an important part of GMAC's financial flexibility, it doesn't transfer away any risk with those transactions," noted Scott Sprinzen, managing director of corporate ratings at Standard & Poor's. "If credit losses related to those securitized assets should breach levels (that were agreed upon) in those deals, GMAC would have to support those losses."

Sprinzen said a severe erosion in credit quality would most likely stem from a serious downturn in the consumer sector of the economy. But he said he doesn't expect that to happen and noted that GMAC has performed well this year.

GM spokesman Dubrowski said the company has a "residual value guarantee" of $1 billion but said this is supported by assets that are equal to, or greater than $1 billion.

"The worst-case scenario is we would have a billion exposure," he said. "But there is no way that debt would come back to GM."

While GM securitizes and sells loans to separate vehicles, it also leases real estate and equipment from various SPEs, which have been established to facilitate the financing of those assets. The leased assets amount to $2.4 billion.

Synthetic Leases

Dubrowski said the company holds about $1.2 billion in synthetic leases and another $1.2 billion in leveraged leases. A synthetic lease is an operating lease that is not recorded as a liability on the balance sheet, but is instead considered to be an expense on the income statement.

Again, such leases are perfectly legitimate, but some experts believe they are another way of making financial results look more attractive than they actually are. The company effectively is able to control a piece of real estate, but is not required to say that it owns the property or that it owes any debt on it.

"The creation of a synthetic lease not only moves the liability off balance sheet, it potentially lowers the cost to the company," because the firm doesn't need to take depreciation expenses on the asset, noted Brotman of Penn Law School.

"Similarly, the whole process of securitization enables a company to front-end income via gain-on-sale of the assets being securitized. This is particularly creative in that the company can control the timing as well as the structure," he said.

A company could potentially record gains on securitized loans, Brotman said, in order to meet financial goals in any given quarter. "I'm not saying GM actually did this, but it's an element that's out there," he said.